Over the past month, energy commodity prices built on year-to-date gains. However, not all energy equities participated, and the laggards could surprise market observers. Brent oil (CO1:COM) rose 2% over the past month and is up ~46% ytd. US natural gas (NG1:COM) prices rose 9% over the past month, and are now up 113% ytd. Thermal coal (XAL1:COM) rose by 27% on the month, bringing ytd gains to 132%.
In a rising commodity price environment the most challenged producers tend to perform the best. The incremental benefit of high prices to a high-cost producer, or a bad-balance sheet business, is much greater than the benefit of high prices to a low-cost producer with a strong balance sheet. Nevertheless, high-quality oil producers like Hess (HES), EOG (EOG) and Pioneer (PXD) rallied over the past month, while lower-quality peers like Laredo (LPI), Murphy (MUR) and Matador (MTDR) saw share prices fall double digits.
Rising natural gas prices (UNG) and strong earnings performance saw best-in-class gas producers like EQT (EQT) trade lower on the month; though, share price performance from Range (RRC), Southwestern (SWN) and SM Energy (SM) was far worse. And with coal rallying double-digits, Arch (ARCH), CONSOL (CEIX) and Peabody (BTU) shares traded flat to down over the past month.
The weak performance upstream could be explained in part by strength in the downstream sector. With refiners like Valero (VLO) and HFSinclair (DINO) trading up over 20% on the month, surely some money left the upstream sector to chase downstream profits. However, when high quality, low-cost producers like Suncor (SU), Devon (DVN) and Total (TTE) outperform in a bullish commodity tape, one could conclude that institutional investors don’t believe in the sustainability of the rally. Rather than scooping up commodity price sensitive names at compelling valuations, like Vermillion (VET) and Murphy (MUR), it appears investors are hiding out in safe, large cap names, while positioning for a correction.
Only time will tell if fading the commodity price rally is the correct call. Weakening economic data and product shortages could threaten demand. Conversely, Goldman’s Jeff Currie said Monday, “we don’t know how high oil prices can go.” With commodity prices higher over the past month, but the shares of the most commodity-price sensitive producers lower, the risk-reward to a “higher for longer” framework has become increasingly favorable.